Short term loans - 5 things you need to know

Sadly, it's often during difficult, stressful times like these that we can make rushed financial decisions when we really need to take our time and, where possible, plan ahead. It might be tempting to borrow more money using quick loans online or another form of short term borrowing. But there are dangers to taking on more debt, especially if you struggle to make ends meet. And as with any form of credit, it's worth considering the risks and options before going ahead.

1. Consider borrowing only what you need
2. Check for cheaper options first
3. Make sure you can pay it back
4. Try to repay sooner rather than later
5. Lenders who offer no credit checks are not always the best
   
   Are all short term loans bad?
   Can I take a short-term cash loan using my credit card?

1. Consider borrowing only what you need

Taking a loan or any form of credit means you are making a financial commitment, and there is a cost, so only borrow money if you have to. Borrowing more than needed may tempt you to spend the additional money unnecessarily.

Borrowing less will mean you have less to pay back. Plus, it's important to remember most short term loans have significantly higher interest rates than regular personal loans.

The less you borrow, the less you will have to pay in interest.

2. Check for cheaper options first

Short term loans, such as payday loans, are costly forms of credit due to their high-interest rates. As a result, considering other payday loan alternatives will likely save you money.

Cheaper options may include:

• Bank account overdrafts - Since April 2020, UK overdrafts have been capped at 40%, and most range from 15% to 39.9% EAR, potentially making an overdraft with your bank a cheaper option.
• Personal loans and bank loans - You may want to compare personal loans particularly if you have a good credit score. Although these are usually designed for more extended repayment periods, you may be able to pay back the loan early.
• 0% interest credit cards - With a zero interest credit cards, you get an interest-free period, typically up to 20 months on new purchases. However, you will still need to make minimum monthly repayments during the grace period. And you'll need a good credit score to be accepted.
• Salary advance - An advance or part payment of your salary ahead of payday may be helpful to cover unexpected repairs or costs and certainly cheaper than a payday loan. However, it will be up to your workplace as to whether you have this option or not.
• Credit unions - Credit unions are similar to banks, except they are non-profit and offer financial services to "closed" member groups. Most charge an average of 1% interest a month per loan. There are currently around 240 credit unions in the UK.
• Friends or family - This option will depend on your current relationships and trust. However, it could be one of the more cost-effective options.

Suitable options with lower interest charges will save you money and may make repayments more affordable.

3. Make sure you can pay it back

As previously mentioned, short term loans are expensive and should be avoided if you are struggling financially. Not paying back on time will affect your credit score, and late payments will be visible to other lenders, reducing your chances of obtaining credit. Late payments and excessive borrowing can lead to a debt spiral and unnecessary money worries and stress.

If you currently struggle to pay all your expenses between paydays or have used a payday loan recently, you could be getting into financial difficulty. It may be better to review your monthly costs and plan a budget to balance your expenses with your income.

One way to check if a short term loan is right for you is to look at how much you will pay each month (monthly repayments). It may be an idea to check the month-end balances on your bank account in the last six months to ensure you can realistically afford the additional cost.

Also, consider any recent changes to your financial circumstances and personal life that may hinder repayments. If you think there is a risk of late payments, it's best not to proceed with the loan application and look for alternatives.

Taking on a payday loan when struggling financially may only worsen matters.

4. Try to repay sooner rather than later

The term of the loan also affects the total you will pay back to the lender. The term is the time you have to pay back a loan. Most short term loans vary from one month to a year (most payday loans tend to be one month). Some lenders may give you multiple options, which can help you with budgeting and planning the repayments.

A longer-term will mean you have smaller amounts to pay each month, but it will also mean there is more interest to pay. To reduce the overall cost of your loan, you may want to pay it back sooner than later. Of course, this depends on what you can realistically afford. And be sure to check that there are no early repayment fees.

The quicker you pay back, the less interest you will have to pay.

5. Lenders who offer no credit checks are not always the best

Authorised UK lenders must perform affordability checks before lending to you. It ensures they are lending to you responsibly and the loan repayments are realistic for your circumstances. A lender may look at your credit score and history as part of these checks.

When a lender has a complete picture, they can evaluate your situation better before deciding to lend to you. So even if you see payday loans with no credit checks advertised, it does not always mean its the best option for you. And even if you have a good credit score, you are not guaranteed to be accepted; a lender must first assess your application.

Bear in mind, though, that credit reference agencies might show payday loans in a different section on credit reports. So when a credit check is performed, lenders, including mortgage providers, could see how often you've used payday loans. And if you are shopping around to for a short term loan, or want to compare payday loans, only provide your information when you know a soft credit check as opposed to a hard check is made. Soft checks on your credit report are not always visible to lenders.

A responsible lender will want to help you in the right way - this means they will perform all the necessary checks to ensure a loan is right for you before lending.

Are all short term loans bad?

Not really. Short term loans can be a convenient way to get money quickly, especially if you are short on options. However, due to the high costs, these loans are best used for those one-off occasions when you don't have any money to pay for an emergency, or you get an unexpected bill. For example, your heating stops working in winter. Or, your car breaks down, and you have no other means of transport and no other way of paying for the repairs.

Getting a short term loan tends to be quicker and easier than most other personal loans. They are also unsecured loans, as opposed to secured loans. Meaning if you fail to pay the loan back, the lender cannot cease any assets as repayment. However, not paying back an unsecured loan on time can still have serious consequences and adversely affect your credit score.

Payday loan lenders still do have a bad reputation for being over expensive and unethical in the past. However, in 2015, the FCA introduced limits on how much lenders can charge. For example, interest rates were capped at 80p per day per £100 borrowed. All fees for a loan default are limited to a maximum of £15, and lenders are not allowed to charge borrowers more than 100% of what they initially borrowed. You may find our guide "Shining a spotlight on short term loans" has more helpful information in this regard.

These and other steps by the FCA have helped make things fairer for consumers. However, there are unauthorised rogue lenders, often individuals illegally operating in the UK. So before submitting any credit application, always check a lender is authorised and regulated by the FCA by searching the FCA register. 

Can I take a short-term cash loan using my credit card?

Yes. Getting cash with a credit card is a bit like a short term loan, except instead of borrowing cash from a lender, you are borrowing from your card provider. This is called a cash advance, and most credit card providers allow you to withdraw money from a cash machine using your PIN. But, it is capped and often not cheap.

Cash advance on credit cards have additional costs as card providers see these transactions differently. There is likely an additional fee to pay (usually around 3% of the transaction or a minimum charge of £3). You'll also pay interest from the day you use the service (there is no grace period). And a higher interest rate will likely apply.

For example, the HSBC Classic Credit Card has a Representative APR of 29.9% variable for regular transactions, which increases to 35.9% for a cash advance. The Santander All In One Credit Card has a Representative APR of 24.7% variable, while cash transactions climb to 29.9%.

In summary

Are short term loans quick and useful? Yes, but that does not mean they are suitable for everyone. In fact, any credit commitments you take on should be done with caution. If you are struggling financially, borrowing more may make matters much worse. Although it can be hard, especially with inflation and interest rates on the rise, it may be better to see where you can cut back.

If you must borrow money, take your time to research and compare loans, and look at alternative credit options as these can be cheaper. Avoid borrowing more than you need and, if possible, save money by reducing the payback period. Be sure to check out the lender and look at what checks are performed before applying. And finally, ensure the lender operates responsibly by putting customer interest first and that they are an authorised UK lender before applying.